Economic GROWTH and FDI gmm

Absorptive CAPACITY, FOREIGN DIRECT INVESTMENT AND Economic GROWTH IN VIETNAM By Lan Phi Nguyen BA (Economics) (National Economics University, Hanoi, Vietnam) MA (Economics) (Institute of Social Studies, The Hague, The Netherlands) A thesis submitted for the degree of Doctor of Philosophy

Absorptive CAPACITY, FOREIGN DIRECT INVESTMENT AND Economic GROWTH IN VIETNAM By Lan Phi Nguyen BA (Economics) (National Economics University, Hanoi, Vietnam) MA (Economics) (Institute of Social Studies, The Hague, The Netherlands) A thesis submitted for the degree of Doctor of Philosophy International Graduate School of Business Division of Business and Enterprise University of South Australia October 2008 ABSTRACT Absorptive capacity of a country (as measured by the size of its human capital ability, level of financial development, technology gap, etc.) plays a crucial role in deriving full benefits from foreign direct investment (FDI) in host countries The issue of the cost and benefit of FDI in host developing countries has been intensely debate for a long time Although this debate has provided rich insights into the role of FDI on economic growth, few empirical studies have considered the case of Vietnam which can be mainly attributed to the lack of appropriate data Since the introduction of the economic reform policy known as “Doi Moi” in 1986, Vietnam has experienced significant economic growth Recent theoretical developments in the areas of FDI related spillover effects and economic growth along with the publication of a new dataset by the General Statistics Office of Vietnam have provided (i) a conceptual framework and (ii) the required data that could be used for an in-depth empirical analysis of the role of FDI and absorptive capacity in facilitating economic growth in Vietnam The thesis starts with an in-depth review of economic growth and foreign direct investment theories These theories are used to critically evaluate policies that are used Vietnamese government to attract FDI in different regions of Vietnam This discussion paves the way for the development of methodology and empirical work presented in the thesis The thesis utilises panel data on 61 provinces of Vietnam Panel data analysis allows one to take into account the impact of unobservable factors and hence yield more reliable results The thesis mainly utilises the Generalised Method of Moments (GMM) estimation technique This technique is considered to be most appropriate because it avoids the potential endogeneity and related complications By making use of quarterly data for the period 1989-2005, the overall impact of FDI on economic growth in Vietnam is found to be positive and significant Provincial data for the period 1996-2005 is used to examine the hypothesis of two-way linkages between FDI and economic growth It is shown that the effect of FDI on economic growth is positive and significant in only four regions of Vietnam; namely Red River Delta, North East, South East, and Mekong River Delta The thesis shows that the absorptive capacity of Vietnam is not sufficiently ii high The empirical analysis suggests that FDI in Vietnam has resulted in technological improvement through backward linkages But the importance of backward linkages as a channel for technological progress is limited to Red River Delta, South Central Coast, South East, and Mekong River Delta which covers approximately 80 percent of the total foreign direct investment in Vietnam The thesis also confirms that FDI has positive impact on international trade, rural household income, productivity, and welfare in Vietnam Furthermore export oriented foreign firms have generated positive spillover effects A number of diagnostics tests have been used to establish the validity of empirical results presented in this thesis The findings of the thesis offer a rich source of material for discussion on policy implications for both of the central and local governments in Vietnam For example, it can be argued that both the central and local governments need to increase spending on education, research and development and infrastructure Financial sector reforms in remote and poor regions including North West, North Central Coast, South Central Coast and Central Highlands are likely to not only increase the inflow of foreign direct investment but also enhance the productivity of such investments in these regions through stronger spillover effects The thesis also highlights the need for specific policies such as those that promote linkages between foreign and domestic firms It is suggested that both the central and local governments can play a role in developing and assisting small and medium-sized firms through increased cooperation with foreign firms Such policy is likely to enhance the benefits form foreign direct investment through horizontal and backward linkages Development of the supporting industries is a key element in facilitating continued industrial development in Vietnam iii DECLARATION This thesis presents work carried out by myself and does not incorporate without acknowledgement any material previously submitted for a degree or diploma in any university To the best of my knowledge it does not contain any materials previously published or written by another person except where due reference is made in the text; and all substantive contributions by others to the work presented, including jointly authored publications, are clearly acknowledged Lan Phi Nguyen 1st October 2008 iv ACKNOWLEDGEMENT During the period of writing this thesis, I have received the support of many people I wish to express my sincere gratitude to them I am deeply grateful to Ass Professor Sajid Anwar, my supervisor, for his valuable suggestion and comments on my work He has been a very responsible and dedicated supervisor I am also grateful to Professor David Round, Dr Martin Shanahan, Dr Xin Deng, and Dr Wendy Bastalich for their helpful and critical comments on my writings Without them it would have been impossible for me to produce the thesis and to complete my PhD program Various other persons have been of great help to me I would like to express many thanks to the Vietnam Development Forum staff members, particularly, Professor Kenichi Ohno, Ass Professor Pham Hong Chuong, and Dr Nguyen Ngoc Son, for all their discussions and criticisms I want to thank my fellow PhD students and the staffs in the International Graduate School of Business and school of Commerce I would also like to appreciatively acknowledge the Vietnamese government for granting me a scholarship and providing financial support to enable me to pursue my PhD program I am deeply thankful for my parents and older sister for their support, encouragement and understanding during my study They are the best things in my life Last but not least, I thank my lovely wife Nguyen Thi Minh Ngan, for her unconditional love and support during the difficult times v TABLE OF CONTENTS ABSTRACT ii DECLARATION iv ACKNOWLEDGEMENT v TABLE OF CONTENTS vi LIST OF TABLES x LIST OF FIGURES x LIST OF ABBREVIATIONS xiii CHAPTER ONE: INTRODUCTION 1.1 Background to the Research 1.2 Motivation for the Research 1.3 Focus and Scope of the Research 1.4 Research Questions 1.5 Research Contribution 1.6 Outline of the Thesis CHAPTER TWO: AN OVERVIEW OF FDI AND ECONOMIC GROWTH IN VIETNAM 2.1 Introduction 2.2 History of FDI and Economy in Vietnam 10 2.2.1 Vietnam Under French Rule 10 2.2.2 Vietnam in the Period 1954-1975 12 2.2.3 Vietnam After the Country’s Reunification 1976-1985 15 2.2.4 Vietnam Under the Doi Moi Policy 19 2.3 24 The Role of FDI in Vietnam in the Doi Moi Period 2.3.1 The Stage 1987-1990: The Promulgation of the Law on Foreign Investment 24 2.3.2 The Stage 1991-1995 25 2.3.3 The Financial Crisis Stage 1996-2000 34 2.3.4 The Stage 2001-2005 38 2.4 43 Conclusion vi CHAPTER 3: LITERATURE REVIEW 44 3.1 Introduction 44 3.2 FDI and Economic Growth 45 3.2.1 Theoretical Analysis of FDI and Economic Growth 45 3.2.2 Empirical Studies on FDI and Economic Growth 53 3.3 61 FDI and Technological Progress 3.3.1 Theoretical Studies on FDI and Technological Progress 61 3.3.2 Empirical Studies on Technology Spillovers or Technological Progress from 3.4 FDI 65 FDI and Trade 72 3.4.1 Theoretical Studies on FDI and Trade 72 3.4.2 Empirical Studies on FDI and Trade 74 3.5 78 FDI and Rural Households 3.5.1 Theoretical Studies on FDI and Rural Households 78 3.5.2 Empirical Studies on FDI and Rural Households 80 3.6 83 Conclusion CHAPTER 4: METHODOLOGY AND DATA SOURCES 85 4.1 Introduction 85 4.2 Methodology and Data Sources 85 4.2.1 Research Question 1: FDI and Economic Growth in Vietnam 85 4.2.2 Research Question 2: FDI and Economic Growth in each Region of Vietnam 98 4.2.3 Research Question 3: FDI and Technological Progress in Vietnam 100 4.2.4 Research Question 4: FDI and International Trade in Vietnam 109 4.2.5 Research Question 5: FDI and Rural Households in Vietnam 117 4.3 122 Conclusion CHAPTER 5: EMPIRICAL RESULTS AND ANALYSIS 124 5.1 Introduction 124 5.2 Research Question 1: FDI and Economic Growth in Vietnam 124 5.2.1 FDI and Economic Growth in Vietnam through the VAR Model: A National vii Level Analysis 124 5.2.2 FDI and Economic Growth in Vietnam through the Simultaneous Equation Models: A Provincial Level Analysis 5.2.3 Summary 5.3 127 134 Research Question 2: FDI and Economic Growth in Each Region of Vietnam 135 5.3.1 FDI and Economic Growth in Each Region of Vietnam 135 5.3.2 Summary 139 5.4 139 Research Question 3: FDI and Technological Progress in Vietnam 5.4.1 The Effect of FDI on the TFP at the Industry Level 139 5.4.2 The Effect of FDI on the TFP at the Firm Level 143 5.4.3 Summary 154 5.5 157 Research Question 4: FDI and International Trade in Vietnam 5.5.1 FDI and International Trade in Vietnam 157 5.5.2 FDI and Export Spillovers in Vietnam 161 5.5.3 Summary 168 5.6 168 Research Question 5: FDI and Households in Vietnam 5.6.1 FDI and Household Income 169 5.6.2 FDI and Household Productivity 171 5.6.3 FDI and Household Welfare 173 5.6.4 Summary 175 5.7 175 Conclusion CHAPTER 6: CONCLUSIONS AND POLICY IMPLICATIONS 176 6.1 Summary and Conclusions 176 6.2 Policy Implications 183 6.3 Limitations of the Thesis 185 viii APPENDIX 1: FDI INFLOWS INTO VIETNAM DURING THE PERIOD 19882005 186 APPENDIX 2: INDUSTRIAL OUTPUT BY REGIONS AND PROVINCES IN VIETNAM IN THE PERIOD 1995-2005 188 APPENDIX 3: SECTORIAL DISTRIBUTIONS OF FDI BY MAJOR FOREIGN INVESTORS DURING THE PERIOD 1988-2005 191 APPENDIX 4: AWARENESS OF THE VIETNAMESE GOVERNMENT ON THE ROLE OF FDI IN PROMOTING ECONOMIC DEVELOPMENT IN VIETNAM 192 APPENDIX 5: INDUSTRIAL SECTOR 195 APPENDIX 6:LIST OF THE INDUSTRY IN TERMS OF TECHNOLOGY 197 APPENDIX 7: ESTIMATED RESULTS FROM EQUATIONS 4.18 AND 4.23 198 APPENDIX 8: ECONOMIC REGIONS AND PROVINCES IN VIETNAM 208 APPENDIX 9: COLLINEARY DIAGNOSTIC TESTS 209 REFERENCES 213 ix LIST OF FIGURES AND TABLES Figures Figure 1.1: FDI Projects Licensed in Vietnam from 1988-2005 by Sector Figure 2.1: Sectoral Distribution of FDI in Vietnam 35 Tables Table 1.1: Geographical Distribution of FDI in Vietnam from 1988 to 2005 by Region Table 2.1: The Five-year Plan (1976-1980): Targets and Performance 16 Table 2.2: Vietnam: The Road to 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